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Netflix Price Increase Doesn't Slow Growth

If any business has shown it can learn from past mistakes, it's Netflix (NASDAQ: NFLX) . The company in 2011 botched a price increase so badly, it bled subscribers, nearly fired CEO Reed Hastings, and drained years of built-up customer goodwill. Three years later, it has pulled off a rate increase flawlessly.

In its latest quarterly financial letter to shareholders, Netflix said it has topped 50 million total members. That's a gain of 1.7 million people in a period that included a price increase for new subscribers in most of its territories, including the United States. That's an improvement on the company's second quarter of 2013, when the digital streaming service added 1.24 million new members. Better yet, Netflix, which reports paid members and total members separately, posted an even bigger gain in paying subscribers. (People on free trial periods do not count as paid members until they are actually being billed.)

For the period, Netflix added about 700,000 new paid subscribers domestically and another 1.15 million across the rest of the world. That's pretty much exactly the same year-over-year growth domestically and about half a million more in total versus the previous year.

The company commented on the lack of impact caused by the price increase in the letter, which was signed by Hastings and CFO David Wells.

In May we raised prices modestly in most of our markets for new members.... We expect ARPU [average revenue per user] to rise slowly as members at the new prices grow as a percentage of total membership. There was minimal impact on membership growth from this price change.

Hastings and Wells are being modest. It's fair to say it actually had no impact, based on the year-over-year quarterly comparison. That's a far better result than three years ago, when Netflix enraged its customer base by attempting to split off its DVD delivery service under a separate brand managed to hike rates 12.5% for new subscribers. This increase is only $1 per month, but those extra dollars pile up fast.

What the successful increase meansSince the rate increase took effect May 12, at almost exactly the mid-point of the quarter, let's assume that half the subscribers are paying the new rate. That means the company has added 350,000 new customers paying $1 more. That's an additional $525,000 in revenue for the six-week period and another $4.2 million during the rest of the fiscal year.

Add in the 1.15 million new paying international subscribers, and the numbers get even better. Using the same 50% ratio of customers joining before and after the increase, that's 575,000 new overseas subscribers paying at least $1 extra. In the quarter, that brought an extra $860,000 -- and $6.75 million over the rest of the year.

Adding roughly $13 million over three quarters is not that big a deal for a company that did $1.14 billion in revenue in the second quarter alone, but it is essentially money for nothing. It's also cash that should continue to snowball as new subscribers sign on each quarter. That's especially relevant for a company that has its biggest growth periods during the fourth and first quarters. If Netflix can even maintain its past-year subscriber growth -- which seems likely, given the current numbers -- it would add 3.5 million paid subscribers in the fourth quarter and nearly another 5 million in the first quarter of 2015. That's $8.5 million in new monthly revenue going forward.

By the first month of Q2 2015, if everything stays on track, that's 10.35 million new subscribers, each adding a dollar to the monthly pile. A million here or a million there may not seem like much to Netflix. But $31 million a quarter, or $124 million a year, is significant, especially because the company collects that money with no added expense.

In finessing its price increase, Netflix has subtly increased its margins in a high-cost, low-margin business. The company has to spend lavishly for the content that lures in subscribers, so making a little more off of each user might mean the difference between success and failure.

An added benefitNot only will people paying the higher rates grow as a percentage of Netflix users, but in May 2016, the rate increases for all customers. That means that in less than two years, the company's subscriber base -- which if current trends hold will be at 72 million -- will all be paying the extra dollar. That number may be aggressive, as at some point the user base will plateau. But even if we use a more conservative 60 million figure, that brings Netflix $720 million in new annual revenue.

In many cases, a price increase causes people to drop a service. Netflix has shown that if you increase rates rarely and carefully, it can be done without angering your users. In 2016, some subscribers may balk at paying $12 more a year, but those numbers will be small.

Netflix is playing a slow, steady game, and it's playing it very well. The company has added meaningful revenue through a well-managed, subtle price increase. It's not inconceivable to think the company could do the same thing again in a few years, adding to its profitability and stability.

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Daniel Kline has no position in any stocks mentioned. He pays for a Netflix subscription but rarely remembers to use it. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Daniel B. Kline is an accomplished writer and editor who has worked for the Microsoft's Finance app and The Boston Globe, where he wrote for the paper and ran the Boston.com business desk. His latest book "Worst Ideas Ever" (Skyhorse) can be purchased at bookstores everywhere.
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